5MF (WEEK 50): SBF’S ARREST, BINANCE OUTFLOWS SOAR, POWELL’S REMARKS

Five Minute Finance

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13 min readDec 16, 2022

The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.

Let’s see what’s going on this week:

Takeaways from SBF’s Arrest and Ray’s Testimony
Huge Binance Outflows: Cause for Concern?
Bond Traders Don’t Really Believe Powell
Hedge Funds are Counting on Rate Cuts Sooner
Sen Warren & Others Propose Digital Asset AML Bill

SBF Arrested: What Happens Now?

Breaking: SEC Charges Sam Bankman-Fried with Defrauding Investors (link)
SBF’s Inner Circle Was Gathering in “Wirefraud” Signal Group (link)

Historic Fraud Wrapping Up

One month after FTX crashed, Sam Bankman-Fried was arrested in the Bahamas on Monday, December 12th, at the request of the US government. This was one day prior to his planned testimony in front of US Congress. You can read his now-canceled testimony transcript here, which starts with “I f****d up”.

However, charges against SBF are numerous and go against his narrative of just sort of passively “f*****g up”. The Securities and Exchange Commission (SEC), led by Gary Gensler, issued a special statement describing SBF’s actions as intentional:

“We allege that Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto”.

Now, some members of US Congress are starting to point fingers, with a lot of fingers pointed in the direction of Gensler.

Congress Representative Tom Emmer noted that FTX was fraudulent from the start. And since Gensler had numerous meetings with FTX to discuss regulatory frameworks (which Emmer says benefited FTX alone), then Gensler “will be held accountable”.

Gensler had previously worked in the same MIT department run by Glenn Ellisson, the father of Caroline Elisson, SBF’s purported girlfriend that ran Alameda Research. Naturally, this background only adds fuel to the fire when it comes what was actually happening in those ‘private conversations’ between SBF and Gensler.

Further, just one week before SBF’s arrest, Congressman Ritchie Toress asked the Government Accountability Office to investigate Gensler’s failure to protect investors from “egregious mismanagement and malfeasance of FTX.”

Royal Bahamas Police Force in Nassau, Bahamas, apprehended SBF on December 12, 2022. Image credit: Mario Duncanson/AFP

Regardless of what will happen with Gensler, information related to charges against SBF are now available.

The US Department of Justice charged SBF with committing or conspiring to commit fraud; conspiracy to defraud the US government; conspiracy to defraud customers by misappropriating their deposits; to defraud lenders; to commit securities fraud and money laundering. Lastly, he was also charged to have violated campaign finance laws.

Considering FTX leadership ran a Signal chat group which they named “Wirefraud” to discuss company operations, these charges seem like they won’t be too difficult to prove.

FTX bankruptcy manager, John Ray, summed up the situation before Congress, at the same hearing SBF was supposed to attend:

First, customer assets from FTX.com were commingled with assets from the Alameda trading platform.
Second, Alameda used client funds to engage in margin trading which exposed customer funds to massive losses.
Third, the FTX Group went on a spending binge in late 2021 through 2022, during which approximately $5 billion was spent buying a myriad of businesses and investments, many of which may be worth only a fraction of what was paid for them.
Fourth, loans and other payments were made to insiders in excess of $1 billion.
Fifth, Alameda’s business model as a market maker required deploying funds to various third party exchanges which were inherently unsafe, and further exacerbated by the limited protections offered in certain foreign jurisdictions.

In the end, what is SBF looking at in terms of jail time?

Based on similar cases, the wire fraud charge alone could net him up to 20 years in prison, which is just one of 8 charges. Bernie Madoff for example pleaded guilty to 11 felonies, three of which SBF is charged with: money laundering, wire fraud, and securities fraud.

Madoff received a 150-year sentence. SBF could get 100 years if convicted on all 8 accounts. But, we all know that the maximum penalty is rarely handed out.

So, what happens in the meantime?

SBF was denied his request to be released on a $250k bail, so he is spending time in Fox Hill, Bahamas’ only prison rated among the world’s worst due to overcrowding and poor conditions. He will be held there until an extradition hearing to the US, set for February 8th, 2023.

Presently, SBF is opposing extradition despite the Bahaman prison conditions. To function “normally”, he told the judge he needs 10 mg of adderall every four hours.

Binance Outflows Soar: Are Investors Just Playing It Safe?

Binance Pauses USDC Withdrawals as Outflows Surge to $2B in 2 Days (link)

Assets Flee Binance

Many investors are clearly worried about Binance.

Digital asset holders are withdrawing their funds in droves. Nansen analytics firm reported $3.6 billion worth of withdrawals from Binance by mid-week.

Binance’s Bitcoin holdings experienced a sharp dip this week, as ~88% of BTC supply is now off exchanges. Image credit: Glassnode

Why the panic surrounding Binance? Is this just PTSD from the FTX situation — or is there cause for such concern?

One lingering factor is Binance’s audit, conducted by Mazars. While the audit suggested Binance was 100%+ collateralized, the audit has ultimately failed to calm market participants.

Mazars own report did “not express an opinion or an assurance conclusion”, meaning it can’t fully vouch for the figures Binance provided to the firm. This has been pointed out by concerned crypto natives.

Also this past week, Binance temporarily paused USDC withdrawals:

Image credit: Twitter

USDC withdrawals were subsequently resumed shortly thereafter.

But, we all know what happened when investors received a similar “withdrawal failed” or endless “withdrawal processing” message when trying to get funds out of FTX.

As a result, this further fueled the panic surrounding Binance.

To add to the mix, reports resurfaced of Binance being investigated for money laundering. These reports initially arose back in 2018.

On Monday, Reuters published an article titled “Exclusive: U.S. Justice Dept is split over charging Binance as crypto world falters”. Here are some “exclusive” quotes:

“Some of the at least half dozen federal prosecutors involved in the case believe the evidence already gathered justifies moving aggressively against the exchange and filing criminal charges against individual executives including founder Changpeng Zhao, said two of the sources. Others have argued taking time to review more evidence, the sources said.”

“Little has been revealed about the case.”

“the Justice Department could bring indictments against Binance and its executives, negotiate a settlement, or close the case without taking any action at all.”

“The new reporting shows that the case has shadowed Binance for most of its five years in existence”

While the article itself had little — if any — substantive developments, such a headline is certainly enough to catch attention.

And in the midst of everything else going on with Binance and the crypto space, the news culminated and further spread shockwaves throughout the crypto market, sparking more fear among investors.

So far, Binance’s CEO sees the latest FUD as a “stress test”. He has encouraged users to reclaim custody of their funds with TrustWallet, enabling people to hold their own private keys instead of the exchange.

With some uncertainty floating around Binance, albeit without any clear red flags visible for the moment, it seems as though investors would rather ‘play it safe than sorry’.

After everything we just witnessed — and continue to witness — with FTX, can you really blame them?

Powell Brings Rates into 2-Year Treasury Yield Territory

Powell Announces 50BPS Interest Rate Hike in 2022’s Final FOMC Meeting (link)
Can the Federal Reserve Bring the Inflation Rate Down to its Target of 2% in 2023? (link)

Bond Market Calls Powell’s Hawkish Bluff

Another month and another FOMC meeting to move the markets and shape our economic reality.

Expectedly, Fed Chair Jerome Powell increased the interest rate by 50 bps for December, bringing the rates into 4.25% — 4.50% range. This was a break from four consecutive 75 bps hikes, which have plunged the S&P 500 (SPX) by -18.71% this year.

Since Wednesday’s FOMC meeting, SPX dropped by -4.2%. Typically, a confirmed reduction in rate hikes is positively received by the markets. But as we noted last week, the market is moving beyond Fed’s immediate moves due to the odds of a recession on the horizon.

While core inflation (excluding volatile food and energy) lowered on a monthly basis, it is still up by 6% on an annual basis. This is 3x higher than the Fed’s ultimate 2% inflation target.

Fed Chair Powell dispelled a potential hike pivot by saying:

“I wouldn’t see the Committee cutting rates until we’re confident that inflation is moving down in a sustained way.”

But does Powell’s math make sense? To get to that target, he projected a 5.1% funds rate by the end of 2023. He also said that rate cuts would be on the table in 2024, but the current inflation decline rate puts rate cuts on the table by next summer.

To ensure that the inflation trend continues downward, Powell still wants wages suppressed. This translates to higher unemployment, one of a recession’s key markers. After all, suppressed wages suppress demand which ends up lowering inflation. When asked directly if wage growth is a headwind, Powell covered his bases:

“We want strong wage increases. We just want them to be at a level that’s consistent with 2 percent inflation. Right now…wages are running well above what would be consistent with 2 percent inflation.”

This is the likely culprit for the market’s downturn after this past week’s FOMC meeting. Powell seems to be prepared to risk a recession as the ultimate inflation douser. His words look to be preparing the macro terrain for it:

“I don’t think anyone knows whether we’re going to have a recession or not and, if we do, whether it’s going to be a deep one or not. It’s just it’s not knowable.”

The bond market (government debt) is not quite buying Powell’s hawkishness, expecting rate cuts next year. This was manifested through a 2-year treasury yield. Typically, it drops when investors lose confidence in the economy, or when they expect the Fed to stimulate the economy with rate cuts.

US 2-year treasury yield surged — and then dropped after Powell’s press conference. Image credit: Bloomberg

And for good reason. Historically, the fed funds rate hasn’t gotten over the 2-year treasury yield.

Policy-sensitive 2-year treasury yield is a good indicator of the Fed’s hike and cut cycles. Image credit: 3F Research

That’s because high interest rates drain the economy, lowering federal tax receipts (revenue). They have already dropped by -10% in November, at -29$ billion from last year. In turn, the government has less means to pay for treasury yields, a form of government debt.

Presently, the 2-year treasury yield is at 4.23%, while the fed funds rate is in the 4.25% — 4.50% range after the latest 50 bps hike. By breaking the historical trend, the Fed seems to be going into uncharted waters.

But as Powell himself said, some things are “not knowable”.

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What Are Hedge Funds Expecting in 2023?

Smart Money is Betting on a Historic Soft Landing for the US: Report (link)

Betting on a Soft Landing

Whether or not the Fed will manage a soft or hard landing is the question of the year.

One is a smooth adjustment without too much disruption, while the other can be a financial crisis marked by a sharp decline in jobs and businesses. For Powell, this is a mystery, yet to be resolved.

For smart money, institutional investors and hedge funds, the bet is on a soft landing. According to a Wall Street Journal report, mutual funds and hedge funds in charge of $4.8 trillion in assets have been investing in stocks that benefit from:

Slowed inflation rate
Interest rate cuts

In other words, they think Powell’s latest speech is a bluff. Holding stakes in energy, materials, and industrial companies, these sectors highly correlate with economic shifts.

Their optimism is two-fold:

Labor market remains strong, at 3.7% unemployment.
Increased consumer spending in October by 0.8%, seasonally adjusted, despite consumer price increases by 7.7% in the same period.

Katie Nixon, chief investment officer for Northern Trust Wealth Management, said that this is a path toward avoiding “the typical scar tissue of a steep economic downturn,”.

To make that happen, US wage growth, presently at 5.1% for nonfarm workers, will have to go down. Powell made this clear:

“Although job vacancies have moved below their highs and the pace of job gains has slowed from earlier in the year, the labor market continues to be out of balance, with demand substantially exceeding the supply of available workers.”

Interestingly, the global wage growth dropped by -0.9% this year, according to WEF. This is the first decline in real earnings in this century.

Image courtesy of Statista

An influx of foreign labor into the US market could then settle the labor imbalance Powell is concerned with. An additional incentive in that direction is the decline in foreign currencies as the dollar gets stronger with additional rate hikes.

Sen Warren Proposes Digital Asset AML Bill

US Senators Warren, Marshall Introduce Digital Assets Anti-Money Laundering Bill (link)

The Impact of the Bill

Together with Sen. Roger Marshall (R-KS), Sen. Elizabeth Warren (D-MA) seems to have taken another swipe at the crypto industry.

Under the framework of combating money laundering, their new bill proposal would have major repurcussions on the crypto space — especially for Americans.

Titled The Digital Asset Anti-Money Laundering Act, it has been dubbed by crypto insiders as the “most significant attack on digital freedom”.

What’s so controversial about it?

Here’s a summary:

Digital wallet developers, miners, and validators would be subject to know-your-customer (KYC) rules.
Financial institutions would be blocked from transacting in funds if they come from coin mixers like Tornado Cash. Likewise, inherently private coins like Monero or Zcash would be prohibited.
The Financial Crimes Enforcement Network (FinCEN) would be able to report transactions coming from self-custodied wallets.

Meaning, all crypto transactions of everyone would be identified and recorded under the bill, without a warrant nor probable cause. As you can guess, this obviously isn’t sitting well with the privacy enthusiasts of the crypto space.

Blockchain advocacy group CoinCenter calls the bill an “opportunistic, unconstitutional assault on cryptocurrency self custody, developers, and node operators”.

Peter Van Valkenburgh, CoinCenter Director of Research, noted that the bill would erode the very notion of permissionless public blockchains for Americans:

“the bill has been deliberately crafted to make permissionless blockchains unavailable to Americans by forcing all validators and developers of these networks to gate and surveil their infrastructure.”

It appears that, if the bill goes through, personal financial privacy is not in the cards for Americans. Ironically, although Sam Bankman-Fried was charged with money laundering, the new bill would effectively curtail self-custody, the very mechanism that can help to prevent against the fraudulent use of funds by crypto exchanges, as seen via FTX.

In this light, Peter and other digital asset advocates see the bill as irredeemable, only to “be opposed in its entirety”.

Tweets of the Week

More evidence of a decline in inflation…
US Import Prices increased 2.7% over last year, the 8th consecutive decline in the YoY rate-of-change and the lowest level since January 2021. Historical average is a 2% increase with data going back to 1985.

@charliebilello

As inflation decelerates investors will think it’s the end of it.
Not my view.
This is a structural problem caused by secular forces:
▪️ Wage growth
▪️ Commodity shortages
▪️ Reckless fiscal spending
▪️ Deglobalization
Inflation develops through waves, we just saw the 1st one

@TaviCosta

SIGNS OF A MARKET BOTTOM AND SIGNS OF A MARKET TOP

@gurgavin

6th worst annual return for #governmentbonds since 1700

@RonStoeferle

The United Nations estimates that $800 billion to $2 trillion is laundered globally every year.
We must outlaw this fiat currency stuff. It’s used for terrorists, rogue nations, money laundering, and evading sanctions. It’s also backed by nothing!

@WClementeIII